Exchange Rate Volatility & Macro Fundamental Effects: A Cumulative Analysis on South Asian Countries

Abstract

In the world economy there are many factors that influence the whole picture of the financial markets that are run by different countries. Though in any economy inflation and interest rate are mostly the dominant factors but exchange rate is also one of the component that can escalate or diminish any country’s economic condition. Exchange rates play a crucial role in the degree of trade in a nation which is important to most of the world's free market economies. For this reason, exchange rates are one of the economic indicators frequently tracked, evaluated and manipulated by government, which is why it is a volatile instrument. An increase or decrease in the exchange rate volatility can be risky for any nation. There are many macro fundamental elements related to exchange rate volatility. Some elements can affect exchange rate volatility directly with different level of intensity and some may not affect at all. The main purpose of this study is to find out which macro fundamental factor (DCF, DCP, DEBT, FDI, FIA, INF, MS, TR) plays the most significant role in exchange rate volatility concerning to all the countries (Bangladesh, India, Pakistan, Sri Lanka, Nepal) base on South Asian region. This study has been based on the 38 years of empirical data starting from 1980 which ends with 2017 related to all the selected countries. By using the OLS based quantile regression model, this study has tried to reach the main objective. Before using the quantile regression model, a unit root test has been conducted to find out whether the factors are stationary or not in the time series. The collective outcome of three types of unit root tests- ADF, PP, and KPSS provides sufficient evidence to make a decision about the data being stationary and also if data is unit root or no unit root. After doing the quantile regression test this study has showed that both government debt and trade openness has both positive and negative relationship with the exchange rate volatility for depending on countries economic condition. Some factors have no significance on some country and some other like foreign direct investment, inflation and domestic credit to private sector has relationship with exchange rate volatility for some country. Though this study has focused on eight macro fundamental factors along with the prime factor exchange rate volatility. However, these eight can be considered as the most vital macro factors in the context of this study.